Ignition! Starting up
Most innovations come from responding to a customer’s needs, or finding a niche where products need improvement or extension. It is rare to innovate using a blank sheet of paper in a room with bare walls and no other contributors.
Imagine the room in which several graduate business school student groups have gathered, tasked with coming up with an idea for a business plan competition. The group starts with a blank sheet, and toils through idea after idea, trying to come up with a product or service that might become the next FedEx. That is tough work, and not a very productive way to start a process. Sometimes, the result is spectacular. Most of the time, this form of thinking produces a plan that requires real work to imagine success.
I’d advise the students to do it differently. I’d advise them to pick a growing industry. Then find a short list of users, customers, and consultants in that industry who are known to be advanced in their thinking as demonstrated by their prior work. Then I’d advise them to visit the CEO. And ask, “What is it that bothers you most about your operation?” “What is you biggest problem, other than working capital?” “Where’s your bottleneck in production or sales or development?” “If you could invent a solution, what would it be?”
[Email readers, continue here...] Now that’s how to find pain in an industry. And yet, few think to use this form of investigation. Yes, you can argue that probably Fred Smith might not have thought of FedEx if he had just interviewed rail or postal customers. But maybe someone would have given Smith the bare idea from which he could imagine a much bigger opportunity.
If you’re starting a new company because you have a better way to do something, create something or market something, you have a head start. But if you’re trying to think of what you want to produce, start with finding the pain in the marketplace, and set out to remove it.
Henry Ford famously said, “If I asked my customers what they wanted, they would have said ‘a faster horse.’” As a mechanical genius, even that comment might have led Ford to envision a way to provide reliable, fast, inexpensive, mechanical horsepower. It is the process of leaping from a need to an eloquent solution that creates demand and ultimately success in the marketplace.
By Frank Peters
I became an entrepreneur because I had to. My life in Corporate America wasn’t going so well. I never got fired, but I did quit one job the day before I was to be let go. I used my employee discount that last day to purchase a Compaq luggable computer and drove with my brother to Las Vegas. Now, this would be questionable therapy for anyone who just became unemployed, except we were heading to Comdex, the annual computer show that would eventually grow huge as would the industry itself. I consider this trip the anniversary of the company’s starting up, and made the trip 11 years in a row.
How was striking out on my own? I’d often say: “I created the company so no one could fire me.” I never took a business course, never wrote a business plan, and never raised any outside capital.
As I look back at insights I might share, I wade through the trite suggestions of ‘work hard’ and ‘treat the customer well.’ But there’s more. Burn the bridges behind comes to mind. I had no alternatives to success. I was not going back to corporate America. It wasn’t a fall- back position. I had to be successful at my new software company. And it wasn’t easy.
[Email readers, continue here...] I remember taking a walk with my wife one evening and sharing my concerns over cash flow. My sales tax payments were due in the next few days, and I didn’t have the money. Default would bring many consequences. But I did have an appointment, a sales opportunity the next morning. I woke up that next morning with a jolt – literally. An earthquake struck Los Angeles. In an hour I received a phone call from the friend who was in the office where I was due later that morning. He had made the introduction for my appointment. “People are pretty shook up here today. Some were stuck in an elevator. I don’t know if today’s the best day to come up.” He wasn’t telling me I couldn’t come, so, because I had to, I did. I made the sale, and paid my debts. I always remember that ‘back against the wall’ feeling. It was stressful and yet so typical when running a small company.
This morning over coffee, my wife told me of a dream she had last night. It was about the earliest days of our life together when we moved to Westwood so I could attend UCLA. “Moving out west away from our families was one of the best things that could’ve happened to us at that early age,” she recalled wistfully. “We had to make a go of it.” It brought back the memories of landing at LAX in 1974 with three suitcases and $1,900 to our names. Like my eventual experience as an entrepreneur, we had to persevere. We had no alternatives. We had burned our bridges behind.
Frank Peters made his money writing software for Wall Street. Today he is best known as the host of the Frank Peters Show, delivered via the web each week to tens of thousands of entrepreneurs, angels and VCs worldwide. Frank speaks and networks at angel events around the world.
“Everybody’s got a plan – until they are punched in the face,” stated boxer Mike Tyson. My experience personally reviewing over three hundred executive summaries each year, all sent to me unsolicited, seems to bear out the truth in Tyson’s statement. Anyone can build a good – or great – plan. Investors have to look behind the plan and at the entrepreneur and his or her team, knowing that, over time, most of us have come to the conclusion that it is the execution of the ever-changing plan, not the plan itself that makes a company a success.
Tyson’s statement also addresses change. The ‘punch in the face’ is analogous to dealing with the business plan when it intersects with the realities of the market. Wham! I can’t recall any of my companies hanging onto its original plan after some level of consumer feedback.
We built one of our companies upon forecasted metrics for a specific class of retail consumer base, but found that there wasn’t enough money in our universe to pay for marketing to create that much dedicated traffic to our site. So we switched to distribution through partners which already had massive amounts of traffic, and concentrated in providing great content and great offers that more than made up for the sharing of revenues.
[Email readers, continue here...] There is a name for such a change in focus, in this case from retail to wholesale. We call it a “pivot,” a term now used to describe great management dealing with successfully refocusing a company in a new direction.
And most of us who invest in so many companies have come to the conclusion that our greatest profits over time come from investments in great management, groups that we are confident are able to execute even on average plans. Some label this as “Bet on the jockey, not the horse.”
Creating a gerat company in a relative vacuum is an exercise in complete trust that the entrepreneur knows what’s best for the customer, perhaps even without interaction with such a customer. It’s probably happened, but not often enough to trust this method as a formula for success.
So, I’ve developed the three step dance in order to help form a repeatable method of how to create a great company from an early idea.
The first step: Involve potential customers early. Even if you know it all – wouldn’t it be an excellent plan to try your idea out on enough actual or potential customers to measure reasonable feedback?
You can use or discard the information you receive. We now know that Steve Jobs created in relative secrecy several of his products that became massive industry drivers of change. The iPad probably would have failed before production, had he used feedback and research from past failures of tablets in any previous form as a guide. On the other hand, most products or services are created in response to a real or perceived need. And most of us are not Steve Jobs.
[Email readers, continue here...] The second step: Take feedback seriously. Making the effort to gather metrics from the field in any form and then ignoring it, takes guts and determination – and in most cases a measure of stupidity. As I analyze business plans, I usually ask the entrepreneur early in the process whether s/he has tried this idea or prototype or mockup out on potential users. And if so, what was the response? And from how many people? In what related universe? I want to know that potential paying customers have been queried using enough information or a good enough model to get a real response worth taking seriously. Without this, any information received is suspect. And failure to make use of the information is a red flag for investors.
The third step: Reiterate and return to customers for comments. Seeking, then analyzing responses allows you to make changes to the plan and product in response. But what if the changes create other problems for the customer, or miss the mark, or don’t drive these same customers to more positive responses? The best possible second round feedback should come from the very same people who took the time to review the offering the first time. They have context and should see effort and progress. Their comments should therefore be more valued than those from first-time respondents.
The three step dance:
- Involve your customers early.
- Take feedback seriously.
- Reiterate and return to customers for comments.
So, why not design your product using your real and potential customers as consultants?
You’ve surely heard the variations on this theme. “Ready, fire aim” was popular in the 1990’s, accredited to any of several authors. I used the term to describe my efforts in the artificial intelligence field, experimenting with new devices, the lisp programming language, and our first trial installations. It seemed an ideal way to describe a scrappy, entrepreneurial activity.
So why do so many business-book authors stress the opposite behavior? Ready, FIRE, aim. What happens to careful planning, sure-fire metrics, quality test scenarios, market research, a good business plan – all in place before pulling the trigger of a new opportunity.
And who is right here?
[Email readers, continue here...] If you’re seeking investment from anyone other than friends and family, you’re probably going to have to navigate through the exercise of careful planning, documentation and execution. Investors are a fickle bunch in general. They want to know that their money is not just being thrown at an idea that will become a trial by fire – literally.
On the other side of the argument is the truth of the claim that numerous iterations in the form of rapid prototypes and execution of new ideas in the field quickly refine the product or service to meet the needs of the customer, and at a far faster and cheaper pace than with careful pre-planning.
In the software arena, there is a term for this: “cowboy coding.” Without the need to carefully document the architecture and elements of a proposed application, a single programmer can much more quickly just code, test, and create revised code. Without even pausing to document the process internally, no-one can easily take over the job, if for any reason the cowboy coder is no longer in control. And the result? Typically, we call that “spaghetti code” to signify code that is so often changed that it no longer looks clean and traceable.
The conclusion is that the best process depends upon the product, its critical core nature to the business using it, and the way in which the entrepreneur approaches the need for outside investors.
Critical components of any operation or business must be carefully constructed, tested and inserted into the operation of the business. On the other hand, if a new free iPad app has bugs, they can be corrected in the next automatic update, and probably without much customer noise.
Which is better for you: rapid iteration or careful planning? What is your case for defending your method of creating new products or services?
Some businesses are built around a single idea. And sometimes that idea is just too small a slice of the big picture to be interesting to investors. There was a recent investor event where I was keynote speaker, on stage only after several panels of experts had wowed the audience with their predictions and observations. One of the panelists made a point that resonated with me.
She stated that she had rejected the investment being discussed, because in her mind the entire company was “just a button, on a feature, in an app.” That comment sent me thinking about relevance, about longevity, and about market size for some of these entrepreneurial applicants looking for funding.
If you have invented a game that will be marketed as a new app in the app store, have you created enough of a model to create an ongoing company, or just another app that will compete with the hundreds of thousands already in the store? Is your game using a unique engine, or series of animated characters, or method of play that will break ground with potential players, inducing them to look to you for more and more unique games over time?
[Email readers, continue here...] Far too many companies have been created around a button on a feature, and not upon a solution to a need in answer to a void in the market. Investors have seen this game before. We match what we see to what has succeeded for us in the past. And rarely do we see a plan for a single product that is not part of a larger vision, and remain interested long enough to ask for more information.
There are exceptions. The famously popular app, “Draw It,” might at first seem an exception, until you dig deeper to find a dense plan around a series of social engagement products planned to follow. Can you extend your product into a planned series? Plan to create apps, not buttons, and not features.
By JJ Richa
Dave’s note: Our guest insight this week is from JJ Richa. JJ is a successful entrepreneur and technologist giving back to the entrepreneurial
community in many ways, including his weekly Internet TV program on entrepreneurism, and participation in several mentoring programs.
Business partnerships have their advantages and disadvantages. Taking on a business partner is like a entering into a marriage. In general, partnerships are easy to get into and difficult to get out of. Certain guidelines should be taken into consideration along with a path to follow – from dating to prenup to marriage – all of which can be applied to a business partnership.
Taking on a business partner can be an excellent strategic decision in helping move the business forward. It should be well thought out for all parties involved. The relationship needs to be synergistic financially, emotionally, and operationally. All parties need to perform due diligence to ensure that the assumptions are correct, that neither partner has financial issues which could affect the partnership, and that the opposite partner has the skills to contribute to the partnership.
[Email readers, continue here...] Most of the important benefits for partnering include:
- Combining of complimentary skill sets
- Access to new markets
- Addition of new services or product lines
- Addition of essential expertise and knowledge to propel the business forward
- Open doors to new distribution channels
- Access to new technologies
- Access to capital unavailable to either partner singly
Certain steps should be taken before entering into a partnership.
1. Personal assessment and getting to know one another:
- Work together on 2-3 projects before an agreement is consummated
- Determine the commitment of the potential partners. Is the potential partner in for the long haul?
- Identify each of the partner’s unique contribution. Does the potential partner bring specialized knowledge, skills, leadership, or experience that compliments others?
- Understand each person’s personal goals. Are each set of goals consistent with the other’s including for example personal wealth, business success, and autonomy?
- Determine trust and Values. Is there trust between the parties? Do the proposed partners share a set of common values? Core values are none negotiable. Be ready to walk away when others are willing to negotiate their own values or try to negotiate others.
2. Determine personal and business goals:
- Contribution: What will the new partner contribute? Example: cash, assets, equipment, connections… Regardless of what it is, a partner’s contribution needs to increase the value of the business.
- Compensation: What are compensation expectations? Example: salary, equity, joint venture, etc… Can the business afford it?
- Control: What type of control is the new partner looking for? Example: percent of ownership, officer/operational, director/board member… What are the parties willing to give up in return for the prospect of business success?
- Brand and Success: Is the new partner dedicated to ensuring brand continuity and contribute to the success, or just to ride on what has been established by the other?
3. Create roles and guidelines in the potential partnership:
- What role and responsibility will each of the partners have including operation, financial, sales, marketing, etc..?
- How will decisions be made and by whom? Is it by committee?
- Will each have certain level of decision making authority? Will the new process impair quick decision making?
- Will authority limits be defined, and processes and procedures put in place?
- What is the understanding if one of the partners wants out or wants more? What is the understanding if things go downhill/uphill?
4. Perform preliminary due diligence:
- Review the business plan including marketing, sales strategies and financial needs
- Review long term company debt, goals, objectives and financial projections
- Review financial statements – up to 3 years if available
- Review tax returns – up to 3 years if available
- Research and talk to existing and past customers
5. Create partnership agreement basic terms:
- Define Key Performance Indicators (KPIs.) How will the success of the business be measured?
- Clarify decision making and dispute resolution processes
- Define each partner’s title and position
- Define management responsibilities and job descriptions
- Detail authority limits for each partner
- Clarify operation responsibilities and metrics used to measure performance
- Define vacations and time off policies such as with partners vacationing at the same time
- Determine compensation for each partner
- Exit strategy planning, including determining what happens when one partner leaves, if closing the business, if selling the business, creating a mutual buy/sell agreement, and more.
Depending on the legal structure of the business, different types of formal agreements may be required.
Partnership agreement should never be 50/50 regardless of the perception of compatibility at the time of execution. There must be some method of resolving a tie that is predetermined in the agreement.
Potential partners should follow and apply these guidelines independently. This should be followed by a joint meeting to determine commonalities, synergies, and conflicts. If necessary, this is the time to bring in an impartial third party to facilitate any possible conflicts and resolutions.
It is highly recommended that legal document are created and/or reviewed by a business transaction attorney. All agreements should be in writing and signed by all parties involved. Regardless of what method is taken to reach an agreement among partners, avoid some of the common mistakes. These include premature rejection of ideas by the other partner, prematurely judging others, one-sided financial consideration, and not sticking to core values.
My dad was a smart businessman, even if not formally trained. He occasionally gave me advice that turned out to be more than wise, looking back at subsequent experience and events. His personal teaching event was a typical experience, as I reflect now upon the tens of partnerships I have counseled over the years. Most often, one partner remained active as another partner drifted away from the business, no longer carrying the weight anticipated at start-up.
It’s just one – the most prevalent – of the many things that can happen to well-meaning partners after time changes plans, and after the business passes through phases of growth or contraction.
I recall one very personal situation when I was very young, that reinforces Dad’s advice. Through my college years, I managed a phonograph record production and manufacturing business that I created as a senior in high school, using independent contractors in local venues to record and edit the original tapes from recording musicals and performances from schools, colleges, churches and organizations throughout the USA and Canada – and then to sell the records to the appropriate audiences.
[Email readers, continue here...] It grew to significant size during my college years, and I associated myself with a “strategic partner” throughout those years, ceding to him all recording and editing of work throughout the large home territory, and any national jobs we received. The agreement was that he would retain all of the revenues generated from those activities. We called ourselves “partners” and received lots of press, even nationally, as we managed our teenage business.
A year after graduation from college, I left for six months to serve my active duty obligation in the US Navy, while others took care of accounting and customer relations. And my “partner” left the company without notice and set up a competing company in my absence, never saying a word to any of us. I was bitter, but unable to do anything about it, since there was no partnership agreement. Luckily, after my return from active duty, my company flourished and his remained a small, one person operation for the rest of its existence. But, as they say, everything he learned, he learned from me. Dad was right, even if I learned the lesson years later.
Investors love it when entrepreneurs draw little or no money from their startups. It extends the cash available for research and other necessary fixed costs and gives the fragile, young company more “runway” to get to breakeven.
But when forecasting the ultimate viability of a business, many times an entrepreneurial founder uses a low, unsustainable salary rate for him or herself in order to show early breakeven. And that is the quandary for investors. If you had to replace yourself with a professional hired to duplicate your skills, what would you have to pay in salary and incentive today? That amount is almost always higher, much higher, than the amount budgeted for the entrepreneur.
You could start by charging more for your executive salary, then paying out less in cash, accruing the rest into a payable amount due to the entrepreneur. But
that is a messy way to demonstrate that you are taking less than market wages from your company. Ultimately, the accrued difference will amount to a large enough liability that several things could happen, all of them negative.
[Email readers, continue here...] The IRS could see that you are not paying yourself interest on the accrued debt, and consider it invested capital, eliminating your ability to repay yourself in the future. Worse yet, the IRS would then consider the accrued amount to be taxable income upon which no tax was paid, since the accrued labor as an investment has value that was not accounted for from previously taxed earnings. Or you could voluntarily convert the loan into stock with a single journal entry and a stock certificate. But the tax effect would be the same if audited – you would owe tax on the booked value.
The solution is to explain to potential investors that you are projecting under-market wages for the founder(s) for a period of time, perhaps until breakeven, and then to agree with them that you will move to market rate at that time.
The biggest error in planning may not be spreadsheet calculation error. Or cost estimation. It is most often missed assumptions about the market, the competition, the speed of adoption, or other critical metrics you’ve researched, or selected, or even just guessed at to create your plan.
Where did you get the data to drive your assumptions of market size or market share? Most entrepreneurs quote a resource for market size, but fail to then take the next step to eliminate all parts of that market unreachable by the company or product. For example, if you supply software to the chip design industry, do you segment your market into digital and analog users, into high end or inexpensive buyers, and into which languages or platforms users demand or request?
It’s easy to find someone to quote a size of market estimate. I became something of my industry’s source for such a number when I carefully catalogued the 160 players both domestic and international, estimated revenues from knowing the number of employees or installations for each (which were often public knowledge or stated by those companies.) I then created a gross domestic and gross international annual market size estimate for my industry’s products. No-one challenged this number, and it became an unattributed source of the metric for market size for years. Perhaps there was no other way to project the size of that market. But many decisions were made within my company walls, and surely by competitors, based upon those numbers.
[Email readers, continue here...] Then there is the famous entrepreneur’s statement about market share: “All I need to sell is one percent of the total available market to make this a rampant success.” We call that the “gloves in China” syndrome when analyzing assumptions within business plans. Without a trace of how the business will get that one percent, the entrepreneur confidently shows that this is all it takes to make us all rich. Even if the total number of annual units in a market is known, the leap to a percent of that market without a specific plan is often a fatal one.
And these are just two of the many assumptions that underlie any business plan. At the very least, all assumptions should be driven by numbers separately listed in an “assumptions section” of the planning spreadsheet, allowing the reader to manipulate those assumptions to see the various outcomes, and challenge the numbers for the benefit of all who have to defend them.